So says Jason Zweig in Your Money And Your Brain, a book on the psychology of investing. The key point he makes is that an investor can be his or her own worst enemy. For all sorts of complicated psychological reasons we can make inexplicably s
illy decisions when investing.
This is especially true in volatile markets – such as today's – when the competing emotions of greed and fear are most pronounced.
Anyone who was able to ride this recent roller-coaster by, for example, selling their investments at the end of 2007 and buying back into the market in the middle of March will have profited handsomely from the market's volatility. But how many people, without the benefit of hindsight, were able to do that? Very few.
Human nature ensures that many investors get their market timing 100% wrong. They hold onto their shares at the top of the market and sell in a panic at the bottom. Even if you don't misread the markets this badly, there are significant risks to being out of the market even for a short time.
Crunching stock market returns for every trading day over the past 15 years, Fidelity has shown that a £1,000 investment tracking the FT All Share from April 30 1993 to April 30 2008 would have grown to £3,647.
Missing just the 10 best days in the market over the period, however, would have reduced the final amount to £2,402, while missing out on the best 20, 30 and 40 days would have reduced the final amount to £1,732, £1,296 and £990 respectively.
Avoiding the 10 worst days would have had an equally dramatic impact. Missing them would have boosted the £3,647 return from staying fully invested to £5,777, for example. Because the best and worst days in the market are very often close to each other, however, timing the market is usually a mug's game.
Six of the best 40 days in the past 15 years and three of the worst have occurred in the first few months of 2008, so anyone out of the market during this period will have taken with one hand but given back with the other. It's just not worth trying to second guess the market in the short-term.
Attempts to time the market are clearly not the way to handle the uncertainty of market volatility. Rather, investors should realise that volatility can actually work for them.
They can turn the ups and downs of the markets to their advantage by adopting a regular savings habit and profiting from a tried and tested technique known as 'pound-cost averaging', which involves saving month in, month out, come what may.
As such it is a fancy term for a simple concept. It works like this: as the market moves up and down, a regular monthly saver buys a varying number of shares with each investment. Over time, this means the average price paid can be lower than the average share price for that period because more shares are bought when prices are low and fewer when prices are high.
Drip-feeding your savings into the market has three main benefits. First, it helps you avoid the natural temptation to stop investing when markets have fallen. Next, it avoids the risk of making a big lump-sum investment just as markets head lower. Finally, it means that in up-and-down markets like today's you will end up with more shares for a given investment than if you jumped into the market with the full amount at the outset.
Putting £4,000 into an investment tracking the FT All Share index at the beginning of 2008 would have left you with £3,831 on May Day. But if you had invested £1,000 on the first day of each month, you would have ended up with £4,110. By keeping that brilliant but unpredictable machine between your ears in check, you gained more money and lost less sleep along the way.
Peter Hicks is executive director, UK Retail, Fidelity International
The full article contains 751 words and appears in Scotland On Sunday newspaper.
